Lloyds Regulatory News (LLOY)

Lloyds Banking Group plc

Q3 2017 Interim Management Statement

25 October 2017

GROUP CHIEF EXECUTIVE'S STATEMENT

In the first nine months of the year we have delivered strong financial performance with increased underlying and statutory profit, a significant improvement in returns and strong capital generation. These results highlight the strength of our customer focused, simple and low risk business model and the benefits of our competitive advantage in the UK. Asset quality remains strong, reflecting our prudent approach to risk, while the UK economy remains resilient.

We continue to focus on supporting people, businesses and communities, as set out in our Helping Britain Prosper Plan while making good progress against our strategic priorities of creating the best customer experience; becoming simpler and more efficient; and delivering sustainable growth. We are ahead of schedule with the integration of MBNA and now expect completion in the first quarter of 2019. We have also recently announced the acquisition of Zurich's UK workplace pensions and savings business which is in line with the Group's targeted growth strategy and accelerates the development of our financial planning and retirement business. A new organisational structure has also been implemented ahead of the announcement of our strategic review in February.

We have announced improved financial targets for 2017, reflecting the strong financial performance in the year, and we remain on track to deliver our longer term guidance.

António Horta-Osório

Group Chief Executive

CONSOLIDATED INCOME STATEMENT − UNDERLYING BASIS

BALANCE SHEET AND KEY RATIOS

REVIEW OF FINANCIAL PERFORMANCE

Strong financial performance with improved profit and returns on both an underlying and statutory basis

Underlying profit in the nine months to 30 September was £6,567 million, 8 per cent higher than the first nine months of 2016 with higher income, positive operating jaws and strong asset quality. Underlying profit in the third quarter was very strong at £2,075 million, 9 per cent higher than the same period in 2016, reflecting a 12 per cent increase in net interest income.

Statutory profit before tax of £4,495 million in the nine months was 38 per cent higher driven by increased underlying profit and lower volatility and other items, which in 2016 included the charge on redemption of the ECNs. Statutory profit after tax was £3,109 million, an increase of 50 per cent compared with a year ago and the return on tangible equity improved to 10.5 per cent (2016: 7.6 per cent).

The Group generated c.185 basis points of CET1 capital in the first nine months of the year with c.85 basis points generated in the third quarter. The CET1 ratio at 30 September after accruing for dividends was 14.1 per cent (31 December 2016: 13.8 per cent pro forma) and the tangible net assets per share were 53.5 pence.

Total income

Total income of £13,893 million increased by 6 per cent in the nine months, with growth in both net interest and other income. Total income in the third quarter was 8 per cent higher than the prior year, reflecting strong growth in net interest income, including £186 million from MBNA, and stable other income.

Net interest income was £9,117 million, an increase of 6 per cent compared with 2016, reflecting a 13 basis point improvement in net interest margin to 2.85 per cent, partly offset by a 1 per cent reduction in average interest-earning assets. The improvement in margin continues to be driven by lower deposit and wholesale funding costs which more than offset continued pressure on asset margins. The period also includes a 5 basis point benefit from MBNA. Average interest-earning assets were 1 per cent lower than in the same period of 2016, reflecting lower balances in run-off, global corporates and closed book mortgages. In the third quarter average interest-earning assets were 2 per cent higher than the second quarter, driven by the impact of consolidating MBNA and growth in key lending segments.

The Group now expects the net interest margin to be stable in the fourth quarter at around 2.90 per cent and for the full year net interest margin to be around 2.85 per cent.

The Group manages the risk to its capital and earnings from movements in interest rates centrally by hedging liabilities which are stable or less sensitive to movements in rates. These liabilities include certain current account and savings balances, together with the Group's equity. As at 30 September the Group's hedge had a nominal balance of £165 billion (30 June 2017: £143 billion; 31 December 2016: £111 billion), broadly in line with the underlying hedgeable balances. The hedge had an average duration of c.3 years and an earning rate of approximately 1.3 per cent over LIBOR (nine months to 30 September 2016: 1.6 per cent over LIBOR). The benefit from the hedge in the first nine months was £1.4 billion over LIBOR (nine months to 30 September 2016: £1.3 billion).

Other income was £4,776 million in the first nine months, an increase of 6 per cent compared with 2016 and included the £146 million gain on sale of the Group's interest in VocaLink recognised in the second quarter. Performance remains resilient with the increase driven by growth in the Lex Autolease business and strong performance in Commercial Banking. Other income in the quarter of £1,428 million was in line with the same period last year. As previously stated in 2016 given the economic climate, the Group does not expect to hold all gilts to maturity. The Group has continued to reduce the size of its gilt and other available-for-sale liquid asset holdings, and has sold c.£9 billion so far in 2017, realising gains of £200 million (2016: c.£4 billion, realising gains of £98 million).

Operating costs

Operating costs were £6,019 million, £60 million higher than 2016 with the increase entirely due to MBNA operating costs of £69 million for the period. Excluding MBNA, operating costs were down year-on-year.

The Group continues to invest significant amounts in developing its digital capability and further simplifying its processes, and delivered further efficiency savings through the Simplification programme in the period. The annual Simplification run-rate savings achieved by the end of September were £1.3 billion against a targeted £1.4 billion by the end of the year.

The cost:income ratio improved to 45.9 per cent (2016: 47.7 per cent) with positive operating jaws in the period of 4 per cent. The Group continues to expect this ratio to be around 45 per cent exiting 2019, with reductions every year.

Impairment

Asset quality remains strong and the loan portfolios are well positioned, reflecting the Group's continued prudent approach to credit risk appetite.

The asset quality ratio for the nine months increased to 16 basis points, reflecting the expected lower provisionwrite-backs and releases. The gross asset quality ratio remained unchanged at 26 basis points, reflecting strong asset quality and despite a single large corporate impairment in the third quarter and the impact of MBNA.

The UK housing market has been resilient and overall credit performance in the mortgage book remains stable. The Motor Finance book benefits from conservative residual values and prudent provisioning with stable credit performance. The credit card book continued to perform strongly, with reductions in persistent debt, and benefiting from a conservative risk appetite. The MBNA portfolio is performing in line with both the Group's expectations and the existing credit card book.

The Group continues to expect the full year asset quality ratio to be less than 20 basis points in 2017.

Impaired loans as a percentage of closing advances improved to 1.7 per cent compared with June 2017 and provisions as a percentage of impaired loans increased to 44.6 per cent.

Statutory profit

Statutory profit before tax increased 38 per cent to £4,495 million (2016: £3,265 million) and statutory profit after tax increased 50 per cent to £3,109 million (2016: £2,076 million). These increases were driven by increased underlying profit and lower volatility and other items, which in 2016 included the charge on redemption of the ECNs.

Market volatility and asset sales of £256 million included positive insurance volatility of £217 million. The credit of £393 million in 2016 included the £484 million gain on sale of the Group's interest in Visa Europe.

The amortisation of purchased intangibles was lower at £64 million (2016: £255 million) as certain intangible assets are now fully amortised.

Restructuring costs increased to £469 million (2016: £390 million) and comprised costs relating to the Simplification programme, the rationalisation of the non-branch property portfolio, implementation of the ring-fencing requirements and MBNA integration costs.

The charges for PPI and other conduct reflect the provisions taken in the first half of the year with no additional charges taken in the third quarter. The outstanding PPI balance sheet provision at the end of September was £2.3 billion. PPI claim levels increased as expected in the third quarter following the FCA advertising campaign, reaching c.16,000 per week and have now reduced to c.11,000 per week, above our assumed run-rate of c.9,000 per week.

Taxation

The tax charge of £1,386 million represents an effective tax rate of 31 per cent (2016: 36 per cent) which is above the Group's medium term expectation of around 27 per cent as a result of the non-deductibility of conduct provisions.

Return on tangible equity

The return on tangible equity for the first nine months improved to 10.5 per cent (2016: 7.6 per cent) reflecting the significant increase in statutory profit after tax in the period. The Group continues to expect to generate a statutory return on tangible equity of between 13.5 and 15.0 per cent in 2019, and delivered statutory returns above this range in the third quarter.

Balance sheet

Loans and advances to customers, at £455 billion, increased by £2 billion compared to 30 June 2017 and by £5 billion since the start of the year. The growth on the quarter was driven by a number of areas, principally open book mortgage balances, up by £0.8 billion, and UK Motor Finance, up by £0.6 billion. This was partly offset by the continued reduction in closed book mortgages and lower run-off balances. The Group continues to expect open book mortgage balances at the end of 2017 to be slightly above 2016.

Wholesale funding was lower at £99 billion (30 June 2017: £102 billion). The Group has continued to draw down the Bank of England's term funding scheme with £18 billion drawn as at 30 September. The Group drew down an additional £2 billion in October and has now fully utilised its £20 billion capacity. The Group continues to meet the Liquidity Coverage Ratio (LCR) requirements, with a ratio in excess of 100 per cent.

In the first nine months of 2017 the Group issued £4.1 billion (sterling equivalent) of senior unsecured securities from Lloyds Banking Group plc which, while not included in total capital, are eligible to meet MREL. Combined with previous issuances made during 2016 the Group remains well positioned to meet MREL requirements from 2020 and, as at 30 September 2017, had a transitional MREL ratio of 23.7 per cent.

Capital

In the quarter we have seen improved capital generation and some upward pressure on capital requirements. Capital generation in the quarter was strong at c.85 basis points with the CET1 ratio strengthening to 14.9 per cent pre 2017 dividends. In the quarter c.60 basis points was from underlying capital generation with c.5 basis points from movements in risk-weighted assets and c.20 basis points from market and other movements. As a result of this performance, the Group now expects to generate between 225 and 240 basis points of capital this year and continues to expect to generate 170 to 200 basis points per annum on an ongoing basis.

The Group's current view of the appropriate level of CET1 capital required to grow the business, meet regulatory capital requirements and cover uncertainties is around 13 per cent. Capital requirements however continue to evolve and during the third quarter the Prudential Regulation Authority (PRA) has increased the Pillar 2A CET1 requirement from 2.5 per cent to 3 per cent. The additional Pillar 2A capital will be held at year end and as a consequence, while other elements are still uncertain, there is upward pressure on the Group's overall capital requirement of around 13 per cent.

The Group is awaiting guidance on the PRA Buffer and will provide an update on capital requirements with the full year results. The Group however still expects to deliver a progressive and sustainable ordinary dividend for the full year and the Board will give due consideration at the year end to the distribution of surplus capital through the use of special dividends or share buy backs.

Tangible net assets per share

Tangible net assets per share increased to 53.5 pence (30 June 2017: 52.4 pence). The increase was due to the Group's strong financial performance in the quarter (2.0 pence) and positive reserve movements (0.1 pence) offset by the payment of the interim dividend in September. The positive reserve movements were driven by favourable movements in the defined benefit pension scheme, due to improved asset returns, more than offsetting the fall in the cashflow hedge reserve as a result of changes to interest rate expectations.

IFRS 9

The Group's IFRS 9 implementation is nearing completion, including embedding of the new systems and processes. It is currently expected that the CET1 capital impact before any transitional relief will be a reduction of between 10 to 30 basis points after taking account of any offset against regulatory expected losses, mainly as a result of additional impairment provisions. As a consequence, on transition IFRS 9 is not expected to have a material impact on the Group's capital position.

Credit ratings

At the end of September the credit rating for Lloyds Bank plc was upgraded by one notch to Aa3 by Moody's. This reflected improvements in asset risk and capital levels combined with an expectation of improving profitability as conduct charges decrease. The Lloyds Banking Group plc (HoldCo) rating was also upgraded by one notch to A3 as a result.

STATUTORY CONSOLIDATED INCOME STATEMENT AND BALANCE SHEET (UNAUDITED)

NOTES

1. Summary of movements in total equity

2. Reconciliation between statutory and underlying basis results

The tables below set out the reconciliation from the statutory results to the underlying basis results.